The Disadvantage of Startup Loans

Many companies have considered entering the market with the immediate introduction of a startup business loan. The reasons for this are often premised around a high degree of confidence that the startup company will immediately be profitable and be capable of repaying lenders with interest. This can be advantageous in many cases, particularly if your company prefers to give up a smaller equity position. However, it is also much riskier and has the potential to destroy the potential of your company in the long-run. This article is designed to provide some things to consider when analyzing your financing options and what to be aware of when reviewing your startup loan options.

Interest rates are high

The interest rates of a startup loan are generally much higher than normal business lines of credit. These high rates substantially increase the liabilities of your company at a time when you would benefit more from having a low cost of capital and minimum liability. The interest rates are generally unsustainably high and give way to liquidity problems as your business grows.

The unforeseen may occur

Debt is a viable option for companies which have a predictable future such as a manufacturing firm that has a purchasing order that it needs to fulfill or an acquisition of a major asset for an established mineral extraction company. However, startup events are difficult to predict and their risk is high because of that. There are many unforeseen events that can wildly alter the revenue and expenses that your company incurs.

They require personal collateral

One of the downfalls of not having business credit is the only thing that may be securitized are your personal assets. This means that if your startup doesn’t succeed and cannot afford to payback lenders, you’re still held liable for the loan. In other words, you may be in the same position taking out a personal loan at a lower interest rate and longer term than going to startup loans that require personal collateral.

Investors bring added value

When it comes to banks, they only hound you about making sure you pay your debt on time. No bank will introduce you to new connections and assist in your business development strategy. Because of this, it is not always helpful to go with banks when you’re sacrificing the resources and reputation that an investment group brings on board. Real investors complement added value resources which cannot easily be acquired otherwise.

Lenders are often predatory

Anytime you deal with lenders that target a market that is underserved, such as those with low credit, the lenders tend to be unforgiving and uncommanding. You can probably image that many of these lenders hear excuses every day from startups and see them constantly fail to pay back their loans. Eventually, they start to not care anymore and just treat every customer with the same disregard and only want their money. Dealing with someone like this at a crucial startup stage can be detrimental to the success and viability of your business at the startup phase.

You immediately have a liability on the books

When you think about the value of your company, you must consider the liabilities that it owes to third-parties. When your company has more liabilities than actual assets, a problem is created. When it has more liabilities than revenue, a bigger problem is generated. The value of your startup is essentially lower because you have liabilities on the books. Hence, it is not entirely advantageous to have such liabilities as your business enters the market.

When it comes to financing, each situation is different. Some companies prefer equity investors from large firms and others prefer debt. In some cases, startups are creative and have a combination of debt and equity or convertible notes. The specific structure that is followed in the financing process is based on many unique factors, but one should certainly be weary to not quickly pursue debt financing strictly for the purpose of avoid giving out equity to investors without contemplating the short-term risk implications.